S-Corp vs Sole Prop savings simulator

When does an S-Corp actually make sense?

The math behind an S-Corp election is straightforward: you save SE tax on the portion of your profit taken as distributions instead of salary, but you take on real overhead costs to do it. The question is whether the tax savings exceed those costs.

As a sole proprietor, every dollar of net profit is subject to self-employment tax (15.3% up to the Social Security wage base). With an S-Corp, only your W-2 salary goes through FICA — distributions bypass it entirely. On $80,000 profit with a $45,000 salary, for example, you'd pay FICA on $45k instead of the full $80k, potentially saving $3,000–$5,000 in SE tax depending on the exact numbers.

The general rule: S-Corp typically makes financial sense at roughly $60,000–$80,000 in net profit in California (or $50,000+ in states with no franchise tax). Below that level, the overhead eats the savings. Above $100,000–$120,000, the savings are usually significant enough to make the added complexity worthwhile.

The breakeven point shifts based on your reasonable salary assumption. A lower salary means more distributions and more SE tax savings, but the IRS scrutinizes very low salaries — and if they reclassify distributions as wages, you'd owe back taxes and penalties.

The "reasonable salary" rule and how the IRS views it

The IRS requires that S-Corp shareholder-employees receive a "reasonable" salary before taking distributions. There is no specific formula — the IRS looks at what someone in your role and industry would earn as an employee. Comparable salary data, your specific duties, and how much time you devote to the business all factor in.

The 40–60% of net profit benchmark that many tax professionals use is a starting heuristic, not an IRS standard. A web designer billing $90,000 who could hire a comparable employee for $55,000 should probably pay themselves closer to $55,000 — not 40% of $90k.

The IRS has audited and won cases where S-Corp owners paid themselves $0 in salary while taking all profit as distributions. A good CPA will document your salary decision and keep it aligned with market rates. The SE tax savings are real, but only if your salary is defensible.

S-Corp costs you need to budget for

Before running the numbers, make sure you're accounting for the full overhead picture:

• California $800 minimum franchise tax — due every year regardless of income. If you're in CA, this is unavoidable and must be paid even in years with a loss.
• Payroll software — you must run payroll to pay yourself a W-2 salary. Services like Gusto or Rippling typically run $500–$1,200/year for a single employee.
• Separate corporate tax return (Form 1120-S) — your CPA will charge more to file an S-Corp return than a Schedule C. Budget $800–$2,000/year in additional accounting fees.
• Bookkeeping — S-Corps require cleaner books than a Schedule C. If you're not doing it yourself, factor in bookkeeping costs.
• State registration and annual fees — if you haven't already formed an LLC or corporation, add state formation fees (typically $70–$150). Annual report fees vary by state.